Small Business Finance:

1
15
Small Business Finance Using Equity, Debt, and
Gifts
Source Entrepreneurial Small Business, Katz
Green, 2e McGraw-Hill/Irwin
2
Chapter 15

• Sources of Financing
• Number one source is from the owners themselves
• Major sources
• Family and friends
• Credit cards
• Trade credit
• Banks
• Commercial lenders

15-2
3
Chapter 15

• Other sources
• Angel investors
• Government programs
• Community-based financiers
• Stock sales
• Venture capital

15-3
4
Chapter 15

• Example
• Finance Your Franchise
• Infinite sources of financing available to help
  you launch the franchise of your dreams
• Never invest more than 75 percent of your cash
  reserves
• 40-year-old Douglas York decided to purchase a
  Great Clips franchise with his wife, he found his
  best financing bet was with a nonbank lender

15-4
http//www.entrepreneur.com/franchises/buyingafran
chise/howtoguides/article36480-5.html
5
Chapter 15

• Financing with equity from the entrepreneur or
  from others
• Personal equity how much you are worth
• Often people underestimate their personal worth
• If you plan to get investments, they may ask to
  see your personal financial statements

15-5
6
Chapter 15

• Financing with equity cont.
• Outside equity money from selling part of your
  business
• Outside equity investors
• Outside not part of the business
• Equity legal ownership rights to your business
• Investors you are using their money
• Partnership, corporation, limited liability

15-6
7
Chapter 15

• Getting Equity Investment
• Owners and investors want to make money
• Lenders expect a return on this money
• To get money from other people, youve got to
  show them that your business probably can make
  gains for them
• Growth potential is a primary concern for equity
  investors

15-7
8
Chapter 15

• Time required to receive gains can be a deal
  killer for potential investors
• Financing with equity is
• Expensive
• Guaranteed to create problems of control and
  decision making

15-8
9
Chapter 15

• Getting outsiders to invest
• Two primary reasons
• You will reduce your own exposure to financial
  loss
• Your business will not have increased costs in
  the form of interest

15-9
10
Chapter 15

• Financing with Debt
• Most common source of capital for established
  ongoing small businesses is borrowed funds
• Three ways
• Direct loans of cash
• Guaranteeing loans made by commercial banks
• Reducing taxes by allowing interest to be deducted

15-10
11
Chapter 15

• Where can a small business get loans
• Your current bank
• Small Business Administration guaranteed loan
  programs
• Numerous small business investment companies
• http//www.sba.gov/INV/index.html
• Incubators or accelerators in your area

15-11
12
Chapter 15

• The Four Cs of Borrowing

15-12
13
Chapter 15

• Gift financing
• Impression might be that a government or a
  foundation hands out money that never has to be
  repaid
• Costs time and money to obtain
• Often requires time and money for accounting and
  reporting to the granting agency
• Two general sources of gift financing
• Institutional
• Personal

15-13
14
Chapter 15

• Sources of gift financing
• Institutional most common is reduced taxes
• Tax abatement a legal reduction in taxes
• Encourage specific activities to improve blighted
  areas
• Tax credits direct reductions dependent on
  meeting some legal criteria
• Encouraging investment in specific assets, to
  increase economic activity, supporting industries

15-14
15
Chapter 15

• Sources of gift financing cont.
• Institutional
• Grants require very accurate record-keeping and
  reporting
• Small Business Innovation Research program
• Small Business Technology Transfer program

15-15
16
Chapter 15

• Sources of gift financing cont.
• Personal gifts forms are as varied as human
  imagination
• Tremendously popular
• 1/3 of small businesses report having unpaid
  labor contributed by family members
• Always more than just a gift
• Loaded with special meanings

15-16
17
Chapter 15

• Forms of Personal Gifts
• Cash
• Picking up the tab
• Accelerated cash-outs
• Free use
• Free work
• Overpayment
• Forgiveness
• Piggybacking

15-17
18
Chapter 15

• Sources of gift financing cont.
• Personal gifts
• Giving a gift also has tax implications
• Put your agreement into writing
• If it is a gift, have the agreement say so
• If it is a loan, have the agreement specify the
  exact interest and payment terms
• If it is an equity investment, consider nonvoting
  stock

15-18
19
Chapter 15

• Example
• Choosing Between Debt and Equity Financing
• Entrepreneurs would much prefer to raise money in
  the form of equity rather than debt
• Why is equity so appealing?
• it feels like you're getting "free" money during
  the startup stage
• usually no repayment obligations and no interest
  payments due to equity investors
• have some say in negotiating the price of your
  stock, any dividend payments and the position the
  investor will have in your company

15-19
http//www.entrepreneur.com/money/financing/startu
pfinancingcolumnistasheeshadvani/article159518.htm
l
20
Chapter 15

• What Type of Financing is Right for Your
  Business?
• Cost of both equity and debt capital changes as
  their relative percentages of total capital
  change
• Few, if any, small business owners even attempt
  to estimate the optimum capital structure of
  their business

15-20
21
Chapter 15

• Why should you borrow?
• Borrowing enhances the potential for higher rates
  of return for the owners
• Borrowing allows the owners to keep a greater
  level of control of the business
• Borrowing increases potential profits by
• Lowering the weighted average cost of capital
• Providing capital funds that allow the business
  to consider additional opportunities

15-21
22
Chapter 15

• Financial Management
• Requires some method to measure and compare your
  financial position and financial results
• Financial position expressed on balance sheet
• Financial results expressed on income statement
• Most financial comparisons are made using ratios
• Activity ratios
• Profitability ratios
• Liquidity ratios
• Leverage ratios

15-22
23
Chapter 15

• Financial Management
• Financial management for start-up
• Primary need is to obtain sufficient funds to pay
  for equipment, buildings, inventory, and other
  costs of starting and running a business
• Funds for start-ups are usually obtained through
  founders personal resources, personal credit
  worthiness, and internally generated cash flows

15-23
24
Chapter 15

• Pecking Order of Funding Sources for New Firms

15-24
25
Chapter 15

• Financial management for growth Bad news-good
  news joke
• Bad news is that the business has greater capital
  needs than ever
• Good news is that more sources of money are
  available to meet those needs
• Emphasis is to obtain increasing amounts of cash
  inflows to pay for added inventory, productive
  assets, and employees

15-25
26
Chapter 15

• Financial management for operations
• Emphasis of financial management is to build
  owner wealth, to conserve assets, to match cash
  inflows to outflows, and to maximize the return
  on capital assets by making optimum investing
  decisions

15-26
27
Chapter 15

• Financial management for business exit
• Successfully leaving your business requires
  maximizing the value of your business for your
  successors
• The emphasis is to create effective internal
  control of assets and liabilities, develop
  business systems to replace your specific skills
  and knowledge, and to ensure that the processes
  of the business and personal transactions of the
  owners are completely separate

15-27
28
Chapter 15

• Summary

3-28